Lean Startups Need Lean Financials

Skinny DollarThanks to Eric Ries, entrepreneurs understand what a lean startup is. The question is, what are lean financials for lean startups and why is it important?

The principles of a lean startup are:

Principle 1.           Document your assumptions (aka hypotheses)

Principle 2.          Launch your company quickly

Principle 3.           Build a minimally viable product and put it in the hands of customers quickly

Principle 4.          Learn as much as possible as quickly as possible from customers

Principle 5.          Use as few resources (aka ‘investors’ money) as possible

Principle 6.          If you are going to fail, fail fast

Principle 7.          Use innovation accounting to chart your progress by converting “guess” assumptions into “known” assumptions.

Ries talks about traditional financials (e.g., pro forma income statements, cash flow statements, and balance sheets) primarily as obstacles to making progress. The thought is that traditional financials are not agile enough for lean startups and that innovation accounting should replace traditional accounting as a measure of true progress. I disagree and here’s why.

Innovation accounting is a tool for measuring progress. But traditional accounting is a tool for determining if you are on a path that makes sense.  Being able to demonstrate that the path leads to the right destination is essential otherwise a great deal of labor and investment will ultimately be wasted.

If your startup doesn’t use traditional accounting there is a good chance you’ve wasted your time using innovation accounting because your startup will fail.

While I support traditional financials playing a substantial part in validating a lean startup, I do agree that they can be hard work and overwhelming.  This is why I propose that traditional financials must be accessible and easy for busy startups to use.  Let’s call this flavor of financials, lean financials.

Lean financials are financial statements that:

  1. Are created with a minimal (ideally no) amount of work so that you can still realize Principles 1 through 6.
  2. Include income statement, cash flow statement, balance sheet, and expected valuations at the time of a planned liquidity event, so they clearly show whether financial returns are possible by all stakeholders.
  3. Are easily adjusted to quickly calibrate assumptions and allow the lean startup to understand what actions to take to make their new business idea more successful.

The first item above enables busy entrepreneurs to invest minimal time in creating substantial financials that validate their great idea.  The second and third items above allow entrepreneurs to provide investors the traditional financial documents they need to make an investment decision without hiring a team of accountants.

The resulting lean financials empower traditional accounting to quickly inform you if you are on the right path. Once this is established, innovation accounting informs you that you are making progress on that path.

And the best part about the evolution of traditional financials into lean financials?  They provide a solid valuation of your startup.  If you had a way of knowing the odds of success for your startup, wouldn’t you use it?  Lean financials is that picture built from your business assumptions and adjustable to follow the impacts of change.

Whoever your stakeholders are, investors, family members, or you, they want to know when they are predicted to see a return on their investment.

 

In summary lean financials are financial statements that:

  • Do not burden you with any extra work
  • Provide you with all the information you need to make informed decisions about whether you are on a solid financial path
  • Allow you to value your startup for investors
  • Enable you to make changes easily to calibrate for success

Davis is a serial entrepreneur currently in his fifth startup. He is also an angel investor and the author of six books.